Breakup and Default Risks in the Great Lockdown
79 Pages Posted: 27 Nov 2019 Last revised: 7 Sep 2021
Date Written: November 15, 2019
In this paper, we exploit CDS quotes for contracts denominated in different currencies and with different default clauses to estimate the risk of a breakup of the Eurozone and the propagation of breakup and default risks after the COVID-19 shock. Our main result is that the risk of a Eurozone breakup is significant although, quantitatively, it is not larger than in the period before the COVID-19 shock. In addition, we find that an increase in the redenomination risk in one country is associated with an increase in default premia and bond spreads in other Eurozone countries. Finally, we find that a sizeable fraction of the changes in the cost of insuring against redenomination and default reflects two additional factors: the first captures the insurance cost against a euro depreciation conditional on \re, while the second captures liquidity premia.
Keywords: redenomination risk, CoVaR, elastic net, Covid-19, default risk
JEL Classification: G10, C31, C45, C58
Suggested Citation: Suggested Citation